Method for adjusting the value of derivative securities due to a corporate event

ABSTRACT

This invention relates to a method for allocating distributions amongst different derivative components of a security upon a corporate event effecting the underlying equity in a manner that factors in the time value of money. The present invention uses the concepts of present and future values with respect to valuing equity derivatives in order to more fairly and accurately represent the interests of the various holders of such components upon the occurrence of a corporate event affecting the value of the equity derivatives.

BACKGROUND OF THE INVENTION

The financial industry created derivative securities (or derivatives) asa way to reallocate risk, create leverage, and provide a wider range ofinvestment opportunities for its clients. These are securities whoseprices are determined by, or “derive from,” the prices of othersecurities. Popular examples of derivative securities include optionsand futures contracts. Standardized forms of these derivatives nowregularly trade on various national and international exchanges. Becausethe value of derivatives depends on the value of the underlyingsecurities, these can be powerful tools for hedging and speculation.

Option contracts, for example, are written on a variety of securities,such as common stock, stock indexes, foreign currency, agriculturalcommodities, precious metals, and interest rate futures. An investor maywish to purchase a call option, which allows the investor (optionholder) to purchase the underlying security at a specified price (knownas the exercise or strike price) during a fixed time period, if theinvestor believes the value of the underlying security will rise duringthat time period. For an American style option contract, if the price ofthe underlying stock rises above the strike price at any time during thefixed time period, the option holder may exercise his option to purchasethe underlying common stock at the strike price and then immediatelysell it at the market price. The option holder will only realize aprofit if the difference between the market price and the strike priceis greater than the original investment (premium) paid for the optioncontract. If the price of the underlying security does not rise abovethe strike price during the fixed time period, the option holder simplyallows the option contract to expire, and his losses consist only of thepremium paid for the option contract.

An investor may also purchase a put option, which allows the optionholder to sell the underlying security at a specified strike priceduring a fixed time period, if he believes that the value of theunderlying security will drop during the fixed time period. For anAmerican style option contract, if the price of the underlying securitydrops below the strike price at any time during the fixed time period,the option holder may exercise his option to sell the underlyingsecurity at the strike price. In order to exercise a put option, theoption holder does not have to own the underlying security. Uponexercise, the investor's broker purchases the necessary shares of theunderlying security at the market price and immediately delivers (or“puts” them) to an option writer for the strike price. The option holderwill only realize a profit if the difference between the strike priceand the market price of the underlying securities upon exercise isgreater than the premium paid for the option. Again, if the price of theunderlying security does not drop below the strike price during thefixed time period, the option holder can just allow the option contractto expire and lose no more than the premium paid for that option.

Conversely, the writers of call and put options can sell these optioncontracts for a premium. They can write options on the underlyingsecurities for a variety of reasons. Security owners who feel bullishabout their security may write a put option feeling that they can gain apremium of the option contract without risking much in return. Securityowners may write a call option as a way of enforcing their selldisciplines. If an investor would sell their security if it reached acertain price in accordance with a disciplined investing strategyregardless of the surrounding circumstances, then such investors canwrite a call option to enforce that strategy and gain a premium inaddition.

The benefits associated with option contracts, which are only one formof derivative securities, are numerous. Investors can use them ashedging devices for minimizing risk. For example, an owner of a securitymay buy a put option on that security at a price that provides theinvestor with the comfort of knowing that he cannot lose more than a setamount of money for a specified time period. Investors can also enforcecertain sell disciplines by writing call options as described above.Additionally, investors can speculate and leverage their stake in anunderlying security through the purchase of call options in thatunderlying security as opposed to the purchase of the actual security.Combinations of the buying and selling of these simple option contractsprovides a variety of products for the financial industry to offer itscustomers, appealing to the various investing strategies belonging to awide range of customers.

The problem with such derivative securities is their treatment upon theoccurrence of a corporate event affecting the underlying security duringthe time period in which the derivative securities are still in effect.Currently, upon the occurrence of a corporate event, such as aliquidating distribution, the holder of the derivative security mustexercise any rights at that time or allow the security to expire. Forexample, assume that a corporate event has triggered liquidation of thecommon stock of a Company XYZ, with full distribution rights uponliquidation. Regardless of the price of the stock upon liquidation, theholder of a call option (the “holder”) must now decide whether toexercise his option to purchase the common stock at the strike price andsell at the liquidating price. Even if the holder makes a profit uponsuch an occurrence, the holder does not gain the true benefit of thebargain contemplated when he entered into the option contract. He losesthe remaining time period in which the underlying common stock couldhave appreciated even further. The holder paid a premium to speculate onthe underlying stock for a specified time period, and now that period isgetting shortened without an adjustment for the loss of time, for whichthe holder has already paid. There is a need for a process that accountsfor the value of time when the holder is forced to exercise his optioncontract before the specified time period has expired, or when anyinvestor is forced to exercise a derivative security before thebargained for time period has come to an end.

OBJECTS AND SUMMARY OF THE INVENTION

This invention relates to a method for providing investors in derivativesecurities the fair value of their investment upon the occurrence of anevent related to the underlying security that forces such investors toexercise their derivatives before the time period allotted to thederivatives has expired. According to this invention, the time value ofmoney is used to readjust the value of the derivative securities for theholder of the derivative security as well as the investor who haswritten the derivative security.

According to an embodiment of the invention, upon the occurrence of acorporate event related to the underlying security, for which thederivative security's allotted time period prematurely expires, theexercise price of the derivative is readjusted to reflect the value ofthe time lost upon such premature expiration. The adjustment of theexercise price is based on a discount rate “r” selected to approximatethe true time value of money. The discount or adjustment of the exerciseprice may equate to a raising or lowering of the price according to thenature of the derivative security. Any predetermined formula may be usedto approximate the time value of money and discount the exercise price.A discounting formula, which is utilized in illustrative examples infra,is used to lower the exercise price according to its present value asfollows:PV=E/(1+r)^(y)PV is the new exercise price adjusted to reflect its present value; E isthe old exercise price; r is the discount rate, which may be chosen tomost accurately reflect the time value of money; and y is the time thatremains after a premature expiration of the allotted time period for aderivative security, expressed in the same units as the discount rate. Arelated formula with the same variables, also utilized in illustrativeexamples herein, is used to raise the exercise price to its future valueas follows:FV=E*(1+r)^(y)

In accordance with an embodiment of the invention, factors other thanthe exercise price of the derivative may be adjusted, upon an event thatcauses premature expiration, to provide the holder and writer of suchderivative with a fairer distribution of the underlying asset. One suchfactor is an income or dividend component of the security, which may beadjusted by taking the present value of the remaining nominal dividendsat the discount rate as follows:

${PV} = {\sum\limits_{i - 1}^{N}\;{D_{i}/\left( {1 + r} \right)^{y}}}$This time PV would be the present value of the stream of income; N isthe number of remaining payments; D_(i) is the stream of income ordividend payments; again r is the discount rate; and y is the time thatremains after a premature expiration of the allotted time period for aderivative security, expressed in the same units as the discount rate.

It is an object of the present invention to properly allocate gains andlosses on investments in derivative securities upon the occurrence ofcorporate events related to the underlying securities, which cause theallotted time period for such derivatives to prematurely expire.

It is also an object of the present invention to adjust the value of oneor more components of securities upon their premature expiration toreflect the value of the time lost.

It is another object of the present invention to utilize the concept ofpresent value to properly discount one or more components of securitiesupon their premature expiration to reflect the value of the time lost.

It is a further object of the present invention to properly adjust thenumber and value of one or more components of securities upon acorporate event related to the underlying securities to properly reflectsuch event.

It is still a further object of the present invention to utilize theconcept of present value in properly adjusting the number and value ofone or more components of securities upon a corporate event relating tothe underlying security to properly reflect such event.

Various other objects, advantages, and features of the present inventionwill become readily apparent from the ensuing detailed description, andthe novel features will be particularly pointed out in the appendedclaims.

BRIEF DESCRIPTION OF THE FIGURES

The following detailed description, given by way of example, and notintended to limit the present invention solely thereto, will best beunderstood in conjunction with the accompanying drawings in which:

FIG. 1 is a flow chart illustrating the activities undertaken upon theannouncement of a corporate event;

FIG. 2 is a flow chart illustrating the activities on the effective dayof the corporate event;

FIG. 3 is a chart illustrating an embodiment of the inventive processwhich allocates funds to the different derivatives of a security upon acorporate event triggering a full liquidation;

FIG. 4 is a chart illustrating an embodiment of the inventive processwhich allocates funds to the different components of a three partderivative security upon a corporate event triggering a fullliquidation; and

FIG. 5 is a chart illustrating an embodiment of the inventive processwhich allocates funds to the different components of a three partderivative security upon a corporate event triggering a merger.

DETAILED DESCRIPTION OF THE EMBODIMENTS

Before referring to the drawings in detail, it will be understood thatfor the purposes of this invention, the terms derivatives, derivativesecurities, derivative security components, derivative components, andcomponents may all be used interchangeably. It will also be understoodthat the term components, derivative components, or derivative securitycomponents can be used to describe the scenario where more than onesecurity derives from an underlying equity, resulting in two or morederivative securities representing components of the underlying equity.

According to an embodiment of the present invention, upon the occurrenceof a corporate event, several financial organizations coordinate thenotification of the event to the appropriate parties, the processing andvaluation of the derivative securities at issue, and the reporting ofsuch valuations. These financial organizations include Depository TrustCorporation (“DTC”), Clearing Corporation (“CC”), and AmericusDerivatives Corporation (“ADC”). They accomplish these tasks in twoseries of events, one taking place on the date that the corporate eventis announced, and the other taking place on the actual date that thecorporate event takes effect.

As illustrated in FIG. 1, a company initiates the whole process byannouncing a corporate event in step 100. The company notifiesparticipant members of DTC, which, on behalf of participant members, mayserve as the repository for the company's equity, in step 110. DTC thennotifies (i) CC, which maintains records that identify all member firmholders of the relevant derivative securities, in step 120; and (ii)DTC/CC participant firm, which can identify customer holdings,.reconcile such holdings to ADC, and notify customers and the company ofrelevant information, in step 130. As set forth in commonly owned U.S.Patent Nos. 5,671,358 and 5,758,097, the present invention can beimplemented using computers at the DTC, ADC, CC and DT/CC participantfirm. The company's computer communicates with the DTC's computer toannounce the corporate event in step 100. As it learns of the corporateevent, the DTC's computer disseminates this information to itsparticipants in step 110. The DTC's computer then notifies the CC'scomputer and DTC/CC participant firm's computer in step 120. The DTC/CCparticipant's computer identifies customer holdings. reconciles suchholdings to ADC's computer, and notifies customers and the companycomputer's of relevant information in step 130.

ADC requests from CC, information that identifies member firm holders ofrecord of the derivative securities pertinent to a derivative securityvaluation, and CC responds with the pertinent information in step 140.That is. the ADC's computer sends a request to the CC's computer forinformation identifying member firm holders of record of the derivativesecurities pertinent to a derivative security valuation, and CC'scomputer responds with the pertinent information in step 140. ADC thenperforms three tasks in order to establish the valuation of the variousderivative securities for the eligible holders of such derivativesecurities:

1. The CUSIP correlation computer means of the ADC's computer performs aCommittee on Uniform Securities Identification Procedures (“CUSIP”)correlation for correlating the equity at issue with the variousderivative securities related to such equity. such as dividend value ofstock (DIWS®), option with limited stock (OWLS®) and residual interestin stock (RISKS®), using the CUSIP component data from a CUSIP file ormemory storage means in step 150;

2. The ADC's computer determines any needed formulas for calculating theeffect of the corporate event on the various derivative securities instep 160; and

3. The ADC's computer reports and confirms the effect on the derivativesecurities with the CC's computer in step 170.

The CC's computer then reports and confirms the effect on the derivativesecurities with DTC/CC participant firm's computer in step 180.

The second part of this process is executed on the effective date of thecorporate event as illustrated in FIG. 2. On the effective date, theCUSIP correlation computer means of the ADC's computer performs a CUSIPcorrelation computation using the CUSIP component data from a CUSIP fileor memory storage means, correlating the equity at issue with therelevant derivative securities in step 200. The ADC's computer thenreceives pricing information from a Market Pricing Service computer instep 210, and uses that pricing information along with the formulaspreviously determined in step 160 (FIG. 1) to compute and store new timeadjusted values for the relevant derivative securities in a computerfile or storage disk in step 220. It is hereby appreciated that thepricing information used in computing new time adjusted values may bethe market price of the derivative on the effective date of thecorporate event, or an average of the market price over a specifiedperiod of time prior to the effective date of the corporate event, orany other predetermined price or pricing formula. The vote apportioningcomputer means of the ADC's computer then allocates and stores values tothe relevant derivative securities based on the time adjusted valuationsin the computer file or storage disk in step 230. The ADC's computernotifies the CC's computer of the adjusted valuations in step 240, wherethe CC's computer adjusts the positions of its member firms to reflectthe adjustments made by the ADC's computer. The CC's computer thentransmits this adjustment information to the member firms' computer insteps 250 and 255, who then identify customer holdings in step 260,adjust the customer holdings accordingly in step 270, and notify thecustomers through a customer statement in step 280.

This invention relates to the process undertaken by ADC in the aboveexamples, or similar financial organizations, in adjusting the effectedderivative securities upon the occurrence of a corporate event. Thisinvention provides ADC, or any like organization which processesderivatives, a process for computing the adjustments to such components,which factors in the time value of money.

TABLE 1 Full Liquidating Dividend Assumed Stock Parameters Dividend $0.00 Stock Price $105.00 Days to Term 1460 Calls Price  29.22 Years toTerm 4 Covered Writes Price  75.78 Termination Claim TC ^(SM) $100.00Standard Deviation 16% Risk Free Rate (a)  6% 1. The Termination Claimis adjusted by taking the present value of the original TC ^(SM)discounted at the risk free rate from the termination date to thepresent 2. Payment to the Covered Writes is the lesser of the adjustedTC ^(SM) or the liquidating dividend. 3. The CALLS receive any moneyleft after the OWLS ® are paid. Adj. Term Claim 79.21 PV of theTermination Claim dis- counted at the risk free rate 79.21 = 100/[(1 +.06){circumflex over ( )} 4] Liquidating Dividend $120.00 $130.00$140.00 $150.00 Value of Covered Writes  $79.21  $79.21  $79.21  $79.21Value of CALLS  $40.79  $50.79  $60.79  $70.79 Call option pricecomparison for a Full Liquidating Dividend of $120.00 Standard InitialOption Americus Price Treatment Treatment Call Option $29.22 $20.00$40.70 Price Change  −9.22  11.57 Percent Change −31.56% 39.58%

According to an embodiment of the invention as illustrated in FIG. 3 andTable 1, the derivative security comprises an American Style call optionon a 100 shares of common voting stock in a blue chip corporation (XYZ)with a five (5) year fixed time period, which will be assumed to equateto 1825 days for the purposes of the calculations for this example. Theholder of the option can exercise or call the option at any time duringthis time period. The holder paid $29.22 per share for this option witha strike price of $100, meaning that the investor can purchase the 100shares of XYZ at the price of $100 per share at any time during theallotted five year time period. One (1) year or 365 days into theallotted one year time period, company ABC makes an offer to purchaseXYZ at a price of one-hundred and twenty dollars ($120) per share. XYZ'sboard accepts and proceeds with a full liquidation of the stock, payingthe shareholders $120 for each share of stock that they own.

According to the current known process for the handling of options in afull liquidation scenario, the option holder would call his option,purchasing the stock at $100 and then immediately selling that stock for$120. The option holder would realize a loss of $9.22 per share, or $922for the 100 shares, as he would gain $20 per share in proceeds afterpaying $29.22 per share for the call option. This example illustratesthe problem existing in the current treatment of derivative securities.The option holder paid the $29.22 per share in order to speculate on theunderlying stock over a five (5) year period. Unfortunately for theoption holder, a corporate event has curtailed this period ofspeculation by four (4) years or 1,460 days. The option holder has notreceived the true benefit of his bargain.

The present invention changes the process of distribution in such ascenario to factor in the value of the remaining time period. Accordingto an embodiment of the invention as illustrated in FIG. 3 and Table 1,the exercise or strike price of the XYZ option is discounted to providethe option holder with a distribution that reflects the value of the1,460 lost days of speculation. Any discounting formula may be used tofactor in the 1,460 lost days. In FIG. 3, the strike price is discountedwith the following formula:S=E/(1+r)^(y)S is the new discounted strike price; for the purposes of this exampleassume that E, the original strike price, is $100, and r, the risk freerate of interest, is 6%, and y, the remaining period of time on theoption contract, is 1460/365 or 4. According to this discount formulathe new strike price, S=100/(1.06)⁴=$79.21. According to the readjustedstrike price, S, the option holder now gains proceeds equal to thedifference between $120 and $79.21, or $40.79 per share, which is $20.79per share more than the proceeds obtained using the standard treatmentof options. These proceeds result in a profit of $40.79−$29.22 pershare, or $11.57 per share, or $1,157 for the 100 shares. The inventivetreatment of this derivative provides the option holder with a return onhis investment of 39.58% as opposed to the 31.5% loss of capitalexperienced with the standard derivative treatment. While the holder ofthe call option realizes more profit, the writer or seller of the optionreceives less money for his shares of XYZ stock. The option writer orseller now only receives $79.21 per share of XYZ stock, which is $20.79less than the amount he would have received using the standard treatmentof option contracts in this scenario. Assuming that the risk free rateof interest is 6%, the option writer or seller, however, could investhis money in short term treasury bonds with the same risk free rate andrecoup the full $100 in 1460 days, which is the remaining term of theoption contract.

TABLE 2 Full Liquidating Dividend (trading in OWLS ®, RISKS ® andDIVS ®) Assumed Stock Parameters Dividend  $5.00 Stock Price $105.00Days to Term 1460 RISKS ® Price  15.32 Years to Term 4 OWLS ® Price 71.84 Termination Claim $100.00 DIVS ® Price  17.84 Standard Deviation16% Risk Free Rate (a)  6% 1. The DIVS ® receives the present value ofthe remaining nominal dividends discounting at the risk free rate. 2.The Termination Claim is adjusted by taking the present value of theoriginal TC ^(SM) discounted at the risk free rate. 3. Payment to theOWLS ® is the lesser of the adjusted TC ^(SM) or the liquidatingdividend reduced by the amount paid to the DIVS ®. 4. The RISKS ®receives any money left after the OWLS ® and DIVS ® are paid. DIVS ®Payment  $17.84 Present Value of the expected future dividendsdiscounted at the risk free rate Adjusted Term Claim  $79.21 PV of theTermination Claim dis- counted at the risk free rate 79.21 = 100/[(1 +.06){circumflex over ( )} 4] Liquidating Dividend $120.00 $130.00$140.00 $150.00 Value of DIVS ®  $17.84  $17.84  $17.84  $17.84 Liq Divless DIVS ® $102.16 $112.16 $122.16 $132.16 Value of OWLS ®  $79.21 $79.21  $79.21  $79.21 Value of RISKS ®  $22.95  $32.95  $42.95  $52.95

According to the embodiment of the invention illustrated in FIG. 4 andTable 2, the inventive method is applied to a different type ofderivative security. According to this embodiment, the derivativesecurity is still based on the underlying common stock of XYZcorporation. The derivative, however, is divided into three components:The DIVS® component represents the stream of dividends distributed tothe holders of each share of XYZ; The RISKS® component represents thespeculation on future gains on the value of each share of XYZ, which issimilar, but not identical, to a call option on XYZ stock; and the OWLS®component represents the nucleus of a share of XYZ stock, absent thedividend and speculative components of that stock, which is similar butnot identical to holding XYZ stock after writing a call option on thatstock. Strictly speaking, the OWLS® is similar to holding the stock andwriting calls on the appreciation and the dividend. It is appreciatedthat all OWLS® and RISKS® can be settled in cash or securities dependingon the contract. The concepts and terminology associated with thesethree component derivatives are fully set forth in commonly owned U.S.Pat. Nos. 5,671,358 and 5,758,097, which are incorporated by referenceherein in their entirety.

According to this embodiment, investors may purchase one or more of thethree derivatives representing the different components as EuropeanStyle, five (5) year derivative contracts, meaning that the derivativewould have a five year term in which it can only be exercised at the endof this 5 year period. The three derivatives may not be exercised duringthe 5 year period, but may be freely traded throughout that time period.It is anticipated that the combination of the derivatives would closelyapproximate the market price of the underlying stock at any time.

The DIVS® would pay the holder of this derivative the dividends that aredistributed on the underlying stock throughout the 5 year period. Thevalue and price of this derivative will approach zero (0) by the end ofthe 5 year term. The price of the DIVS® derivative is always based onthe expected remaining dividend distribution for the XYZ stock for that5 year term.

The RISKS® would pay the holder of this derivative, at the end of the 5year term, the price of XYZ stock at the time over the terminationclaim, which is similar but not identical to a strike price. This wouldrepresent a settlement of differences between the termination claim andthe current market price of the stock at termination. The contract wouldstate whether the settlement of the differences is paid in cash orsecurities. If at the end of 5 years, shares of XYZ are trading at orbelow the termination claim, then the holder of the RISKS® derivativereceives nothing. If, however, the price of XYZ stock is trading abovethe termination claim at the end of the five year period, the holder ofthe RISKS® derivative receives the difference between the market priceof XYZ stock and the termination claim. The termination claim is set atthe beginning of the 5 year period, and the RISKS® derivative is pricedaccordingly. Throughout the five year period, the RISKS® derivative ispriced similar to a call option.

The OWLS® derivative is what remains of a share of XYZ stock after theDIVS® and RISKS® have been removed. The holder of this derivative at theend of the 5 year period receives the price of the underlying XYZ shareup to the termination claim. If the market price of XYZ shares at theend of the 5 year period is equal to or greater than the terminationclaim, then the holder of this derivative is paid an amount equal to thetermination claim. If XYZ's market price is below the termination claimat the end of the 5 year period, then the holder of the OWLS® derivativereceived the full price of the stock. The OWLS® derivative is pricedaccording to the relation between the termination claim and XYZ's marketprice.

It is appreciated that common stock can be further divided into four (4)or more components trading as derivative securities. For example, inaddition to the RISKS® and DIVS®, the OWLS® derivative can be furthersubdivided into levels of appreciation with different terminationclaims. The OWLS® derivative described above can be subdivided intoOWLS1 with a termination claim of $50, OWLS2 with a termination claim of$75, and OWLS3 with a termination claim of $100. Once the 5 year periodis over, the holders of (i) OWLS1 would receive the market price of XYZup to the $50 termination claim; (ii) OWLS2 would receive anyappreciation of XYZ common stock over $50 up to the $75 terminationclaim; and (ii) OWLS3 would receive any appreciation of XYZ common stockover $75 up to the $100 termination claim. The market would price thesederivatives according to the relative risk of the derivative securitywith the OWLS1 being the least risky of the OWLS® derivatives and OWLS3being the most risky of the OWLS® derivatives. The concepts describedherein for the three component derivative securities can just as easilybe applied to four or more components.

According to an embodiment of the invention as illustrated in FIG. 4 andTable 2, the sale of XYZ corporation occurs 365 days into the 5 yearterm (assuming 365 days in a year for simplicity of calculations)leaving 1460 days (4.0 years) on the tern of the DIVS®, RISKS®, andOWLS®). For the purposes of this example, assume that the terminationclaim (TC^(SM)) was set at $100, the risk free rate, r, is 6.00%, andthe annual dividend is $5.

According to the embodiment of the invention illustrated in FIG. 4 andTable 2, a corporate event, such as the sale of XYZ, triggers a fullliquidating dividend of XYZ shares prior to the expiration of the 5 yearperiod for the holders of the DIVS®, RISKS®, and OWLS®. Under astandard-like option treatment, the DIVS® holders would receive nothingfrom such a distribution. Additionally, the RISKS® holders would not getthe benefit of the full five year period to allow the stock toappreciate as they had anticipated. The OWLS® would benefit unfairly asthey would receive the full benefit of their bargain without having toawait the full 5 year term. If the liquidating dividend was $120, thethree components would receive the following distributions: DIVS®holders would receive $0, RISKS® holders would receive $20, and theOWLS® holders would receive $100. The termination claim is not adjustedto reflect the lost period of speculation for the RISKS® holders and theDIVS® simple lose their stream of income.

The inventive method, however, would result in the followingdistributions that account for the time value of money: First, the DIVS®holder would receive the present value of the remaining expected nominaldividend payments, which, for this example, is equal to $17.84. Second,the termination claim is discounted to represent its present valueconsidering that there are 4.0 years remaining on the term of thederivatives. Using the 6.00% risk free rate, the original TC^(SM) of$100 is reset to its present value of $79.21. Accordingly, holders ofthe OWLS® derivative receive $79.21 per share. Finally, the holders ofthe RISKS®) derivative receive all of the remaining distribution, whichfor this example is $22.95 per share.

TABLE 3 Mergers (trading in OWLS ®, RISKS ® and DIVS ®) 1. If thesurviving company is the issuer of the components, no adjust- ments forthe DIVS ®, OWLS ® and RISKS ® will be made. 2. If the issuer is not thesurviving company, the stock of the acquiring company will underly thecomponents. 3. If the original company is acquired for stock and cash,the com- ponents will be adjusted as for a partial liquidating dividend.4. The DIVS ® holder will receive: i. If the dividend of the acquiringcompany is greater than that of the issuing company, the DIVS ®component will receive the new company's dividend ii. If the dividend ofthe acquiring company is less than the divi- dend of the issuingcompany, the DIVS ® will receive the present value of the differencebetween the old and new nominal dividend for the remaining term of theDIVS ® discounted at a predetermined rate.

According to the embodiment of the invention illustrated in FIG. 5 andTable 3, XYZ corporation participates in a merger with ABC corporation.If XYZ is the surviving corporation, then no distributions are made andno adjustments need to be made to the derivative securities based on thestock of XYZ corporation. If the XYZ is not the surviving company, thena few options arise. One example is that no distributions are made, andthe surviving companies stock simply replaces the common stock as theunderlying assets for the derivatives. Another example involves theacquisition of XYZ for stock and cash. For this latter example, thederivatives will be adjusted as for a partial liquidating dividend asdiscussed in relation to Table 5 herein, with the remaining stockunderlying the DIVS®, OWLS® and RISKS® until the end of the contractperiod, i.e., 5 years.

TABLE 4 Special Dividend (trading in OWLS ®, RISKS ® and DIVS ®) 1. TheDIVS ® receives a portion of any special dividend representing up to 3%of the stock's price on the ex-date of the special dividend. 2. TheOWLS ® receives any remaining portion of the special dividend. 3. Thevalue of the special dividend, reduced by the payment to the DIVS ®, isadjusted to be its future value based on the maximum potential IRR ofthe OWLS ®. 4. The Termination Claim is reduced by the future value from3. Special Dividend $10.00 DIVS ® Payment  $3.15 Based on the amount ofthe special dividend and 3.0% of the stock's price 3.15 = 105 * .030Payment to OWLS ®  $6.85 Portion of the special dividend pay- able toOWLS ® 6.85 = 10.00 − 3.15 OWLS IRR  8.62% Expected IRR of the OWLS ® tothe Termination Claim 8.62% = Annualized IRR from 71.84 to 100 over 1460days Future Value of Dividend  $9.53 Future Value of the SD, reduced bythe DIVS ® payment, based on the IRR of the OWLS ® to the Termin- ationClaim 9.53 = (10.00 − 3.15)*(1 + 0.0862){circumflex over ( )} (1460/365)Adjusted Term Claim $90.47 Term Claim reduced by the future value of thespecial dividend. This value is used to determine the payout to theOWLS ® and RISKS ® on the termination date 90.47 = 100.00 − 9.53Expected Ex-date Values as the Result of a Special Dividend Stock $95.00Stock price reduced by the special dividend RISKS ®  12.72 Calculated(Black & Scholes) using $95 stock price, 90.47 adjusted Ter- minationClaim and $5.00 dividend DIVS ®  17.84 PV of 4 years of nominaldividends ($5.00) discounted at the risk free rate OWLS ®  64.44Residual value based on the new stock, RISKS ® and DIVS ® OWLS IRR10.19% OWLS IRR going from 64.44 to 90.47 in 1460 days

According to an embodiment of the invention as illustrated in Table 4,XYZ issues a special dividend, which is not part of the stream ofdividends anticipated by the holders of XYZ common stock. XYZ, whoseshares at the time are trading on the market at $105/share, issues aspecial dividend of $10.00 with 1460 days remaining in the term of thederivatives.

Again, one possible treatment of special dividends would result in thefollowing distributions: the DIVS® and RISKS® holders would receive $0from this distribution, the OWLS® holders would receive the full$10/share, and the termination claim would remain unchanged. In analternative treatment, the DIVS® holder receives the entire specialdividend.

According to an embodiment of the inventive method as illustrated inTable 4, the distributions are made to the derivative holders in thecontext of the time value of money. Assume for the purposes of thisexample that the termination claim was set at $100, the OWLS® derivativeis currently trading at $71.84, and the annualized internal rate ofreturn (IRR) for this derivative equal to 8.62%. The annualized IRR isthe rate of return needed for an investment of $71.84 to reach thetermination claim of $100, which is what the OWLS® expect to receive, inthe remaining 1460 days. The DIVS® holder receives the portion of thespecial dividend representing a specified percentage of the currentmarket price of the underlying equity security. This percentage may bedetermined by several methods, including, but not limited to thefollowing: ADC may set the percentage prior to the issuance of theDIVS®; ADC may set it upon the issuance of the special dividend; aspecial committee within the corporation may be in charge of setting it;it may be the function of another variable such as the risk free rate ofreturn; it may be standardized by the financial industry. In thisexample, assume that the DIVS® receive a distribution from the specialdividend up to 3% of the stock's price, which in this case is $105*0.03or $3.15. If the special dividend is less than 3% of the stock's price,then only the DIVS® holder participates in the distribution and no otheradjustments need be made. In this example, the special dividend is$10.00, so the DIVS® holder gets a $3.15/share distribution, and thereremains $6.85 to be distributed. The OWLS® holder receives the remainderof the special dividend, in this case $6.85. The termination claim wouldthen be adjusted to reflect the current $6.85 distribution to the OWLS®holders. The termination claim can be adjusted by deducting the futurevalue of the $6.85 distribution using the 8.62 annualized IRR for theOWLS® derivative, which equals $6.85*(1+0.0862)^(4.0) or $9.53. Thetermination claim is reduced to $100−$9.53 or $90.47 to fairly reflectthe future value of the current distribution to the OWLS® holders, whichacts like an early withdrawal of their initial investment for the OWLS®holders. RISKS® holders are no longer penalized upon XYZ's distributionof special dividends, allowing them to recoup the loss of capital to thecorporation, which is likely to be reflected in a lower stock price,through a properly reduced termination claim.

TABLE 5 Partial Liquidating Dividend (trading in OWLS ®, RISKS ® andDIVS ®) 1. DIVS ® will receive the present value of the reduction, ifany, in the dividend paid on the underlying stock. 2. Adjusted PLD(PLDn) = PLD reduced by the payment to the DIVS ® 3. If the PLDn is lessthan the present value of the Termination Claim i. Adj. TC ^(SM) equalsthe original TC ^(SM) reduced by the future value of the PLDn based onthe potential IRR of the OWLS ® to the TC ^(SM) ii. The OWLS ® are paidthe adjusted PLD. 4. If the PLDn is greater than or equal to the presentvalue of the termi- nation claim. I. The OWLS ® get paid the presentvalue of the termination claim. ii. The Termination Claim is adjusted tozero. iii. The RISKS ® get the remaining portion of the adjusted PLD(PLDn − PV(TC ^(SM) )). iv. Any future liquidating dividends will bepaid to the RISKS ® and DIVS ®, the OWLS ® having been completely paid.Value of PLD $40.00 New Stock Dividend  $3.50 Announced by the companyReduction in Dividend  $1.50 1.50 = 5.00 − 3.50, the reduction in theannual dividend due to the PLD PV of the Term Claim 79.21 PV of theTermination Claim dis- counted at the risk free rate 79.21 = 100/[(1 +.06) {circumflex over ( )}4] Payment to DIVS ®  $5.35 5.35 = PV of 1.50for 4 years dis- counted at 6.0% Payment to OWLS ® $34.65 Portion of PLDdue to the OWLS ® to make up for the decrease in the Termination Claim34.65 = 40.00 − 5.35 OWLS IRR 8.62% OWLS IRR before the PLD Adjusted PLD55.68 Future value of the PLD using the OWLS IRR to the TerminationClaim Adjusted Term Claim 44.32 Termination Claim reduced by the futurevalue of the PLD. This value is used to determine the payout to theRISKS ® and OWLS ® at the termination date. 44.32 = 100 − 55.68 ExpectedEx-date Values as a Result of a Partial Liquidating Dividend Stock$65.00 Pre ex-date stock price reduced by the amount of the PLD RISKS ®20.68 Black & Scholes RISKS ® price using $65.00 stock price, $44.32adjusted Termination Claim and the $3.50 new dividend DIVS ® 12.49 PV of4 years of $3.50 annual nominal dividends discounted at the risk freerate OWLS ® 31.83 New residual value of the OWLS ® OWLS IRR 8.63% OWLSIRR going from 31.83 to 44.32 in 4 years

In an embodiment of the invention illustrated in Table 5, XYZcorporation issues a partial liquidating dividend (PLD). First, theDIVS® holders will receive the present value of any reduction in thedividends paid on the underlying stock. The PLD will then be adjusted bydeducting any payments to the DIVS® holders. The adjusted PLD will bedenoted as PLD_(n). Then the present value of the termination claim(TC^(SM)) is compared to the PLD_(n). If the present value of theTC^(SM) is greater than the PLD_(n), then (i) the TC^(SM) is adjusted bydeducting from it the future value of the PLD_(n), which is based on thepotential IRR of the current market price of the OWLS® needed to reachthe TC^(SM) upon expiration of the derivative; and (ii) the OWLS®holders are paid the full PLD_(n). If, however, the PLD_(n) is greaterthan or equal to the present value of the termination claim, then (i)the OWLS® holders get paid the present value of the termination claim,meaning that they have been paid on their investment and no longer havean interest in the underlying asset; (ii) the termination claim isadjusted to zero; (iii) the RISKS (holders get paid the remainder of thePLD_(n), which is the PLD_(n) reduced by the present value of theTC^(SM); and (iv) any future liquidating dividends are paid to theRISKS® and DIVS® holders.

According to the embodiment of the invention illustrated in Table 5,with 1460 days (4.0 years) left in the term of the derivatives, XYZissues a PLD of $40.00. The annual dividend was decreased from $5 to$3.50 over the last 4.0 years. As in previous embodiments, the TC^(SM)is $100 and the risk free rate of return is 6.00%. Under one possibledistribution, the DIVS® and RISKS® holders would have received $0 whilethe OWLS® holders would have received the full $40/share and thetermination claim would have been reduced by $40 (TC^(SM)=$100−$40=$60).

According to the inventive method of an embodiment illustrated in Table5, the PLD would have resulted in the following distributions andadjustments to the derivatives. First, the DIVS® holders would havereceived a payment of $5.35 per share, which is the present value of the$1.50 loss in the annual dividend for the next 4.0 years, to make up forthe decrease in dividend payments resulting from this PLD. The PLD isthen adjusted via a reduction of $5.35, leaving a PLD_(n) of $34.65.This value is then be compared with the present value of the TC^(SM),which is equal to $100/(1.06)^(4.0) or $79.21. As the TC^(SM) of $79.21is greater than the PLD_(n) of $34.65, the OWLS® holders receive thefull adjusted partial liquidation distribution of $34.65. In addition,the TC^(SM) must be adjusted by a deduction of the future value of thePLD_(n) based on the OWLS IRR of 8.62%. The future value of the PLD_(n)is equal to $34.65*(1.0862)^(4.0) or $55.68, and the adjusted TC^(SM)should now be $44.32. Hence, at the end of the five year period, if thestock price is trading at any price above $44.32, that excess willbelong to the RISKS® holders while the OWLS® holders would only receive$44.32 per share at that time, offsetting their current $34.65distribution.

TABLE 6 Spin-offs and Split-ups (trading in OWLS ®, RISKS ®andDIVS ®) 1. The RISKS ®, OWLS ® and DIVS ® contracts will be backed bythe shares of the original company and the spun-off company. 2. Assumingeach original contract were for 100 shares, the adjusted contract willbe for 100 shares of the spinning company and 100 times the number ofshares of the spun-off for each original contract. 3. The DIVS ® willreceive the dividend paid on the new companies times the number ofshares of each distributed per contract. 4. At termination the value ofthe underlying shares will be computed as the price of each times thenumber of shares of each per contract. 5. The dollar value of stock eachcomponent receives will be calculated as in a normal termination, basedon the termination claim and the combined value calculated in 4. RISKS ®receive nothing if the combined value from 4 is below the TC ^(SM) . 6.The number of share of each company the OWLS ® and RISKS ® receive willbe the percentage value or that each component repre- sents of thecombined value from 5, times the number of shares each companyrepresents in the contract. Assume 1/4 share of Original company 2 foreach On Effective Com- Post Spin-off original share and Date: pany Co. 1Co. 2 the TC ^(SM) is $100 Shares/contract 100 100 25 Price/share$100.00 $87.50 $50.00 100 = 1.00*87.5 + .25*50.0 Value/contract $10,000$8,750 $1,250 share price times shares/cont Relative value 100.00%87.50% 12.50% The fraction that each company represents of the originalcompany Dividend/share  $5.00  $4.00  $4.00 Announced by companiesDividend/ $500.00 $400.00 $100.00 Dividend times contract number ofshares per contrac On Termin- Com- ation Date: bined Co. 1 Co. 2Value/share $135.00 $110.00 $100.00 Assumed prices for companies 1 & 2,and combined contract value. 135 = 1.00 * 110 + .25 * 100 Value/contract$13,500 $11,000 $2,500 Price per share * shares/cont OWLS ® % 74.07%Value of OWLS ® Combined as a percent of the combined value 74.074% =10,000/13,500 OWLS ® $10,000 $8,148.15 $1,851.85 Split based on thevalue value of each company 8,148.15 = 11,000 * .74074 1,851.85 =2,500 * .74075 OWLS ® 74 18 Number of shares of shares Co 1 & 2 OWLS ®cash   $8.15  $51.85 Cash in lieu of fractional shares RISKS ® % 25.93%Value of RISKS ® Combined contract as a percent of the combined value25.93% = 3,5000/13,500 RISKS ®  $3,500 $2,851.85 $648.15 Split based ofthe value value of each company 2,851.85 = .2593 * 11,000 648.15 =.2593 * 2,500 RISKS ® 25 6 Number of shares of shares Co 1 & 2 RISKS ®cash  $101.85  $48.15 Cash in lieu of fractional shares

According to an embodiment of the invention illustrated in Table 6, XYZspins-off another company ABC. Upon such an occurrence, the derivativesare now backed by a combination of both XYZ (hereinafter referred to as“XYZ′” and ABC share). XYZ shares have been spun-off so that there is a¼ share of ABC for every share of XYZ′. Accordingly a derivativescontract backed by 100 shares of XYZ is now backed by 100 shares of XYZ′and 25 shares of ABC. After the spin-off, the XYZ′ shares trade at amarket price of $87.50 while the ABC shares trade at a market price of$50. Relative to overall dollar value, the derivatives are now backed by87.5% XYZ′ shares, (100 sh*$87.50)/(100 sh*$87.50+25 sh*$50), and 12.5%ABC shares, (25 sh*$50)/(100 sh*$87.50+25 sh*$50).

For the remainder of the contract term, the DIVS® holders receive thestream of dividend from both XYZ′ and ABC multiplied by the number ofshares they hold of each of these companies, which should be 4 shares ofXYZ′ for every share of ABC. Upon termination of the contracts, XYZ′ istrading at the market price of $110/share while ABC trades at the marketprice of $100/share. An OWLS® holder who initially owned 100 shares ofXYZ with a TC^(SM) of $100, has a derivative security that is now backedby $11,000 (100 sh*$110) worth of XYZ′ stock and $2,500 worth of ABCstock (25 sh*$100), or $13,500 worth of the combined stocks. The OWLS®holders, however, are only entitled to $10,000 of the $13,500 based onthe original termination claim of $100 with respect to the original 100pre-spin-off shares of XYZ. Accordingly, OWLS® holders are only entitledto 74.074% ($10,000/$13,500) of the proceeds from each of XYZ and ABC,which entitles them to $8,148.15 of XYZ proceeds and $1,581.85 of ABCproceeds. If OWLS® holders were being paid in the underlying shares ofthe companies with cash in lieu of fractional shares, these values wouldtranslate to a distribution of 74 shares of XYZ stock plus $8.15 and 18shares of ABC stock plus $51.85. The RISKS® holders would receive theremainder of the proceeds equating to $3,500, which would be adistribution of $2,851.85 of XYZ proceeds (or 25 shares of XYZ plus$101.85) and $648.15 of ABC proceeds (or 6 shares of ABC plus $48.15).

While the present invention has been particularly described with respectto the illustrated embodiments, it will be appreciated that variousalterations, modifications and adaptations may be made based on thepresent disclosure, and are intended to be within the scope of thepresent invention. It is appreciated that although the invention hasbeen described with respect to derivative securities with any number ofcomponents, the disclosed invention may be similarly applied toderivative securities with one or more components. It is intended thatthe appended claims be interpreted as including the embodimentsdiscussed above, the various alternatives that have been described, andall equivalents thereto.

1. A computer-implemented method for adjusting the value and terms ofequity derivatives to account for time value of money due to anoccurrence of a corporate event that affects the value of said equityderivatives, comprising the steps of: receiving, via a computer,financial information regarding said equity derivatives comprising atleast a termination claim of the equity derivative and the length of theequity derivative contract, wherein each equity derivative representingone of three economic components of an underlying security, a DIVScomponent, a RISKS component, and an OWLS component, wherein the DIVScomponent represents a stream of dividends distributed to holders of theunderlying security, the RISKS component represents a speculation onfuture gains of the underlying security, and the OWLS componentrepresents the remaining value of the underlying security absent theDIVS and RISKS components, wherein the termination claim determines thepayout between the OWLS and DIVS components at the end of the equityderivative contract; receiving, via the computer, informationidentifying a corporate event that affects the value of said equityderivatives; adjusting, via the computer, the termination claim of theequity derivatives to its present value based at least on the length oftime remaining on the equity derivative contract to account for the timevalue of money; determining, via the computer, any needed formulas, froma plurality of predefined formulas, for determining the effect of thecorporate event on the DIVS component, RISKS component, and OWLScomponent, wherein said determined formulas account for the time valueof money; adjusting, via the computer, the value and the terms of theDIVS component, the RISKS component, and the OWLS component based on thedetermined formulas and the adjusted termination claim; notifyingholders of said equity derivatives, via the computer, the adjustedvalues and terms of said DIVS component, RISKS component, and OWLScomponent; and storing the adjusted termination claim, the adjusted DIVScomponent, the adjusted RISKS component, and the adjusted OWLS componentin a computer storage disk.
 2. The method of claim 1, wherein adjustingsaid termination claim further comprises adjusting said terminationclaim based on a discount rate, wherein said discount rate is either therisk-free rate or a pre-determined rate.
 3. The method of claim 1,wherein said corporate event is a full liquidating dividend.
 4. Themethod of claim 1, wherein the adjusting of the components furthercomprises adjusting said DIVS component to the present value of aremaining stream of dividends expected on said underlying security. 5.The method of claim 1, wherein said corporate event is a partialliquidating dividend and wherein said termination claim is adjustedbased on a future value of said partial liquidating dividend.
 6. Themethod of claim 5, wherein adjusting said termination claim furthercomprises adjusting said termination claim based on either the risk freerate of return or any other predetermined rate.
 7. The method of claim5, wherein adjusting said termination claim further comprises adjustingsaid termination claim based on an expected internal rate of return ofone of said equity derivatives.
 8. The method of claim 5, furthercomprising the step of adjusting said DIVS component to the presentvalue of a remaining stream of dividends expected on said underlyingsecurity which will no longer be paid due to said partial liquidatingdividend.
 9. The method of claim 1, wherein said corporate event is aspecial dividend and wherein adjusting said termination claim is basedon a future value of said special dividend.
 10. The method of claim 1,wherein adjusting said termination claim further comprises adjustingsaid termination claim based on a change in structure of underlyingsecurities due to said corporate event.
 11. The method of claim 10,wherein said corporate event is a spin-off or split-up resulting inmultiple entities and wherein s said termination claim is allocatedamongst said multiple entities.
 12. The method of claim 9, wherein theadjusting of the components further comprises: adjusting said DIVScomponent to receive a specified percentage of said special dividend;and wherein adjusting said termination claim is based on a future valueof said special dividend less any distribution made to said DIVScomponent.
 13. The method of claim 1, wherein the adjusting of thecomponents further comprises: adjusting the DIVS component based on aremaining stream of dividends expected on said underlying security;adjusting the RISKS and OWLS components based on distributions to saiddividend component and said termination claim.